Question

(a) With the aid of a clearly labelled diagram, critically analyse the implications of a small nation,
Mazyopa Republic, imposing a 100 percent ad valorem tariff on the commodity of its
comparative disadvantage.
[30 Marks]

Answer 1

Trade between two countries can benefit both countries if each country exports the goods in which it has a comparative advantage. This is a crucial insight into the comparative advantage.

Suppose Mazyopa republic have an international trade relationship with India and both the country producing cloth and food respectively.

Here we will not discuss all the relative factors and other things which are involved between these two countries in their trade, we will focus on the impact of ad Valorem tax on the commodity of its comparative disadvantage

The direct effect of a tariff is to make imported goods more expensive inside a country than they are outside. The price changes caused by tariff change both relative supply and relative demand. The result is to shift in the terms of trade of the country imposing the policy change and in the terms of trade of the rest of the world.

The terms trade are intended to measure the ratio at which countries exchanged goods. For example how many units of food can Mazyopa import for each unit of cloth that it export? The terms of trade therefore correspond external, not internal prices. When analyzing the effects of tariff we want to know how it will affect relative supply and demand as a function of external prices.

If Mazyopa imposes 100 per cent tariff on the value of food imports,the internal price of food relative to cloth faced by Mazyopa producer and consumer will be 100 per cent higher than the external relative price of the food on the world market. Equivalently the internal relative price of cloth on which Mazyopa resident base their decision will be lower than the relative price on the external market.

At any given world relative price of cloth , then, Mazyopa producer s will face a lower relative cloth price and therefore will produce less cloth and more food. At the same time, Mazyopa will shift their consumption toward cloth and away from food from the point of view as whole the relative supply of cloth will fall (see the attached diagram below from RS1 to RS2) while the relative demand for cloth will rise from (RD1 to RD2).clearly the world relative price of cloth rise from (Pc/Pf)1 to (Pc/Pf)2 Thus Mazyopa terms trade improve at forging expense.

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